25 November 2009

The Cambridge Trust for New Thinking in Economics has organised a conference in January 2010 - details available here.

New thinking in economics is an interdisciplinary approach to economic problems that acknowledges and respects the insights and analysis from other disciplines, especially those from ethics, history and engineering as well as complexity and evolutionary theory. Four issues can be highlighted, each of which has been either ignored by traditional economic modelling of the problem or treated in a misleading way that discounts the insights from heterodox economics and other disciplines.

The economy is a complex, non-linear dynamic system with technological change inherent in economic growth. Many economic policy issues are potentially non-marginal changes to the system in the context of strong uncertainty.

Many issues of economic policy (traditionally called “welfare economics”) are primarily ethical-economics in nature, and should be informed by moral philosophy rather than economics in isolation. Traditional economic models adopt an extreme form of utilitarianism, with a questionable choice and use of discount rates, ignoring the philosophical literature and the concept of justice.

Engineering and history inform economics through studies of the production processes involving the supply and demand of materials, energy, skills and entrepreneurship. Economic history is critical in understanding the relationship between economics and technological change because the technologies evolve in response to economic conditions, e.g. carbon-price signals. Traditional models assume continuity and path independence.

The politics of mitigation implies unstable alliances and trade-offs between governments and political parties. By the use of the social welfare function (required for the calculus), traditional economists simplify social choices and pre-empt political negotiation, claiming an optimality for their subjective assumptions and market interpretations

What I appreciate best are the principles governing the work in the Trust:

(a) that economic behaviour is primarily social rather than individual;
(b) that economic behaviour is influenced by aesthetic and ethical values as well as economic values: and
(c) that the pursuit of self-interest in economic behaviour can impact adversely on both society and the environment.

24 November 2009

The Right to Information Act in India has managed to do wonders in ensuring that benefits of govt. programmes and policies reach the intended targets:In an interview with Wall Street Journal, Aruna Roy, activist (former administrative officer and Magsaysay Award winner) explains how:

WSJ: On the Right to Information (RTI) Act, with which you've been closely associated since its inception 4 years ago, what is the progress so far?

AR: The RTI has become a lifeline for democracy in our country. Despite the failures of various state commissioners or government to implement Section 4. (This mandates the government to publicly disclose as many as 17 bits of information, including its budget, personnel, areas of work, etc.) That's why today the government can't touch the RTI without touching the whole of India. Because it's been used by a variety of people for a variety of reasons, with reasonable success. Sharing information is sharing power and nobody understands this better than the bureaucracy and the politicians, in that order.

But the people are now asking for their, for our share of governance, our share in decision-making, in fact if the tribals of India had had RTI 40 years ago, the situation that we face today wouldn't have happened. Wherever I travel, people feel the RTI is their Act and they own it. This is a fundamental change from what existed years ago.

Of course, a number of problems remain, of infrastructure, non-delivery, of systems not being in place, information commissioners not being trained, etc. But on the whole, the Act has worked.

WSJ: But despite its success, the government wants to amend it. Why?

AR: The government wants to put all file notings under wrap. Meaning, all discussions, consultations, all reasons for decision-making should become secret. Which means you'll know nothing about the process, just the end decision.

WSJ: But so far the process has been open?

AR: Yes, so far the process has been open, although they now want to close that. The Department of Personnel & Training which comes under the Prime Minister's Office, which is responsible for the functioning of the RTI, is now saying that the "consultative process" as well as anything that protects the "candour" of people expressing their opinion, will not be revealed. Behind this move to amend the Act and to kill its spirit, is the bureaucracy.

WSJ: So the government which gave the RTI to the people four years ago is now taking it away?.

AR: Equally horrifying is that all applications which are "frivolous or vexatious" will be disallowed. Now who is going to decide what that is? Possibly, the policeman or the 'patwari' (village revenue official) or the 'sarpanch' (village headman)… Naturally, everything will be "vexatious"…The move undermines the entire Act itself.

WSJ: You've been involved with the NREGA on the ground, how well do you think it has worked?

AR: I will say that this is the first rural development service where people know what they are receiving so they can monitor it, where there has been concurrent evaluation, where we know what the losses or gains are. So, every time I read about corruption in the NREGA I am thrilled, not because there is corruption but because for the first time, so many people are protesting against waste of public money. India should be proud.

WSJ: Give me an example…

AR: A women's group in Sitapur, Uttar Pradesh, has got 1400,000 rupees ($29,710) as unemployment allowance because they applied for work and didn't get it. According to the Act, you have to get work in 15 days within five kilometers of your village, and if the government can't give you work, it has to pay you unemployment allowance…Could you ever think of something like this before?

WSJ: But what about the enormous leakages and lakhs of rupees down the drain…

AR: For the first time, we know where the money has gone, even if its down the drain. We know who's swindled it and how it has been swindled. In Bhilwara, in Rajasthan, we have just completed a social audit. We used RTI to access public records and bring them out into the public domain, share it with people whose names are on the records and took a public meeting to testify whether their names were rightly or wrongly there.

You see, RTI is a mandatory provision in the NREGA, which means transparency and accountability on the part of government functionaries is now mandatory. That's how you find out what's going on, because now the people can't be refused information. It's mandatory for every 'panchayats' to do a social audit before the next installment of money is released by the government.

Read more about social audits and government-public relations in the interview.

While the RTI amendment is being fought, it is not being given enough prominence in the media. Peeyush Bajpai's blog post points to the role of media and RTI :

The power of RTI lies in the hand of the citizen- the “aam-aadmi”, it gives him the power to get the information. In nine out of ten cases the information would concern specific issues to an individual or a small community.

Unfortunately, these amounts and issues are 'too small' to 'merit' national attention and reports fall by the wayside, even though there is so much happening on this front.

As Peeyush points out:

The media houses have always prided on their role as custodians of impartial information dissemination. This is thus a challenge for the media to evolve a mechanism of disseminating such specific information in a focussed manner.

23 November 2009

Axel Leijonhufvud's latest piece in Voxeu concludes:
(I have put some sentences in bold font to emphasise the most pertinent points being made)

There are four issues to watch for:

Twin dangers looming ahead are Japanese-style stagnation on the one hand and Latin-American-style high inflation on the other. In more normal times, we would regard these prospects as both unlikely and very far apart on a spectrum of eventualities. High levels of public debt, large unfunded liabilities, and large current deficits mean that they are not at all far apart in the current situation. The apparent political difficulties in decisively remedying the public finances are likely to mean that this is not just a temporary predicament. The navigable channel between Scylla and Charybdis has become quite narrow.

One overwhelmingly important fact should guide policy over the near-term future – since current bailouts and stimulus policies have stretched public finances to the utmost, governments do not have the fiscal resources to handle another bubble bursting. Policy, therefore, should be conducted in a fail-safe mode. The current policies of extremely low interest rates are not fail-safe. They are aimed at reflating asset prices just enough to stave off a deeper recession. This is a delicate operation, not a robust, fail-safe move. It is creating strong incentives for the banks to return to the tables and resume the game of maturity transformation at high leverage that got us into our current troubles in the first place. It is evident that the banks are responding promptly to those incentives

High leverage has been the big culprit in the current disaster. To reduce the risk of another crash, we must curb leverage. But governments do not want the financial sector to deleverage now because the requisite falling asset prices and curtailed credit would deepen the recession. The question, of course, is: If not now, when?

The central banks are planning “exit strategies” by which they mean returning their balance sheets, which are presently bloated beyond recognition with a mix of strange assets, to a condition more resembling that normal to central banks. This will not be easy. If they succeed, however, they will still face the prospect of having to engage in many of the same desperate, unconventional policies in a future crisis. Under present arrangements, the responsibilities of central banks have no well-defined limits. This problem can only be solved by regulation of the financial sector. At present, it does not seem that we know how to do it.

13 November 2009

Mark Thoma points to the conference on the theme 'Whats wrong with modern macroeconomics' at Munich last week.
Some excerpts from the comments on thatTHOMA: One thing I learned from it is that I need to read the old papers by Sonnenschein (1972), Mantel (1974), and Debreu (1974) since these papers appear to undermine representative agent models. According to this work, you cannot learn anything about the uniqueness of an equilibrium, whether an equilibrium is stable, or how agents arrive at equilibrium by looking at individual behavior (more precisely, there is no simple relationship between individual behavior and the properties of aggregated variables - someone added the the axiom of revealed preference doesn't even survive aggregating two heterogeneous agents).

Roberto Cruccolini said... I think, this phenomenon of forgetting and/or neglecting former knowledge, e.g. the whole discussion and aspects of aggregation, which is really central to the methodology of modern macro, as the notion of microfoudations via optimizing agents was one of the core-arguments of New Classical Makro Revolution, is deeply unsettling. You could also add the oblivion of coordination & interaction problems, of discontinuities & emergence as probably central aspects of makroeconomics, which seem to be the reasons, why macro was once thought to be necessarily a different approach than micro.There seem to be two ways to deal with this finding. One is to complain about the way modern macro has developed, and to suggest other/better solutions; this is, what we see most of the time right now.That is of course worthwhile and understandable, but there remains a strange aspect: nearly all of nowadays criticisms were already mentioned 20 or 30 years before (recall Solow 1978 at the same conference as Lucas & Sargent, or Summers 1986 in response to Prescott, or Blinder 1987, or, which is sort of funny, Kirman 1989 & 1992 and - again - 2009,...)And this leads to the interesting question, why modern macro/new classical methodology & thinking was so successful in conquering the field:why did economists think, that Lucas 1976 said something new, given the reflections of Marshall how to theorize given ever changing structures, given Haavelmos ideas on the autonomy of economic relations, given the debates between Keynes and Tinbergen of econometrics and structural instability, and so on?And why did they follow him in applying a Walrasian program using the representative-agent methodology given all these challenging aggregation results (see for the makro-production-function Fisher 1969 or Fisher&Felipe 2003 & 2006 and the bunch of literature to the Cambridge Capital Controversies and of course the literature interpreting the Sonnenschein-Mantel-Debreu results, f.e. Rizvi 1994 or 2006)And in what sense does it make sense to describe modern macro models as "microfounded", if at the same time, you need some Friedman-1953-as-if argumentation to justify & make plausible your way of modeling, which is often referred to, that the inner functioning of your model is a black box and unknown, only built to generate predictions, not less. but certainly not more, in the sense that we think the way of modeling is reasonably realistic and corresponding to some mechanisms in the real world. Why should we, or why is this commonly called "microfoundations"??

There's a video interview up on Real-World Economics Review Blog:
Ha-Joon Chang and Kevin P. Gallagher talk about the central theme of their books:

Chang demolishes some of the myths on free trade and points to the need for asymmetrical protectionism benefiting the developing nations, for poorer nations to break the model of low return primary commodity based production etc.

Bad Samaritans; The myth of free trade and the secret history of capitalism. Bloomsbury.

Gallagher focuses on Mexico and NAFTA and talks of the US-Mexico policy, the need for developing countries to move away from attracting FDI, for the sake of inflows, and to look at the integration of these flows into the economies, rather than creating enclaves within.

The Enclave Economy Foreign Investment and Sustainable Development in Mexico's Silicon Valley by Kevin P. Gallagher and Lyuba Zarsky, The MIT Press

10 November 2009

Three papers up on Voxeu examining the impact of the fall of the Berlin Wall, 20 years on.Michael Burda's article Half-empty or half-full?East Germany two decades later concludes:It’s my guess that East Germany in the 21st century will reproduce the existing north-south divide in the West. This is because convergence is not only about equating East and West Germans’ levels of physical and human capital but also endowing them with the same level of social, institutional, business and marketing infrastructure. On this metric, the Eastern German economy looks like a mixed bag, like much in life, a glass half-empty and half-full at the same time.

This is an important paper, its conclusion has interesting implications for all states with wide regional disparities

Volker Nitsch and Nikolaus Wolf's paper Tear down this wall:on the persistence of borders in trade reports:Notably, it makes hardly any difference whether we analyse data for 101 regional units and 10 industry groups or 27 regional units and 24 industry groups: the trade effect of the former Iron Curtain across Germany continued to be highly significant throughout the period under investigation, although this effect clearly declined over time. Given that we can extrapolate the results, we estimate that it would take between 33 and 40 years, or roughly one generation, to remove the effect of the former political border entirely.These findings are difficult to square with the “political barriers” or the “artefact” explanation of border effects but strongly suggest that some fundamentals are driving the effect. We conclude that the biggest challenge to globalisation is neither technological nor political barriers to trade, but barriers stemming from economic fundamentals. While we can change infrastructure and even remove political borders, it takes at least a generation to tear down the wall in our heads.

Gerlinde Sinn and Hans-Werner Sinn's Muffed jumpstart puts their conclusion baldly:Germany’s political unification has succeeded; its economic unification has not....The failed unification of the East and West German economies has also dragged down West Germany in an international comparison. Until German unification, West Germany had grown properly and in terms of per capita national income had held a top position in Europe, at about the same level as Denmark. Under favourable conditions, it could have maintained this growth thereafter and Germany as a whole could have grown much faster than the rest of Europe due to the convergence of East Germany to the Western European level. But this is not what happened. Since 1995, both parts of the country have crept along in step and have taken turns with Italy for the lowest rung on the European ladder. Things turned out worse than we had expected.The economic crisis has enforced a new realism in Germany. Net transfers to East Germany have been declining for a few years, wage increases have become more modest, and the constitution prohibits East German states to continue their policy of rising indebtedness from 2020. The times of easy money are past, and that is why a phase of growth may start now. Unfortunately, it is twenty years late.

05 November 2009

This is a mail from Suyodh Rao who points to two articles:
The first by Gillian Tett Financial Times 'Rally fuelled by cheap money brings a sense of foreboding'
The second by Roubini also in the FT 'Mother of all carry trades faces an inevitable bust'

The two put together answer some questions as to why asset prices are rising even though things dont 'feel' so good. Companies are reporting decent results no doubt. I have not looked at Market PE Ratios, that will give a better idea whether equities are reasonably or otherwise priced.
The factor that cannot be ignored is where the money that is being pumped in by govts is finally ending up. One chunk of stimulus money obviously went to shore up financial institutions balance sheets. Leftovers of that stimulus will find its way into either consumer prices or asset prices.
What the articles talk about is how the loose monetary policy & the fiscal stimulus of the US are both fueling worldwide asset price inflation. Realty prices world-over are still on the higher side when one compares them to trend-line relationship with incomes. Incomes (real) are down if anything and should push house prices even lower. As for stock prices, one will have to look at PEs.
The current crop of policy-makers seem to have not read their Economic History texts, or have forgotten them. While that may sound like an audacious statement, I take the support of two statements of two individuals (quoted below) who, in most respects, have had the most impact on economic policy-making in the 20th century (and onwards). In the days when these were written, there weren't the fancy hedge and fence funds of today. Nor was the stock market hogging newsprint. That may have allowed them to give Money Supply the respect that was due to it. There were three variables that they focused on - Employment, Output & Price Level. Today the financial sector employs tens of times more folks (percent of workforce), and that has changed the focus of policy. In my opinion, that is an unwelcome change. But then, the counter-tautological statement would be that if the financial sector goes down the drain, then the real sector is doubly hurt. That statement has its merits. But, since the financial sector doesn't matter, let us tinker with it. Therein lies our mistake.

There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. John Maynard Keynes, 1920

My own studies of monetary history have made me extremely sympathetic to the oft-quoted, much reviled and as widely misunderstood, comment by John Stuart Mill. "There cannot ....," he wrote, "be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order".

True, money is only a machine, but it is an extraordinarily efficient machine. Without it, we could not have begun to attain the astounding growth in output and level of living we have experienced in the past two centuries - any more than we could have done so without those other marvelous machines that dot our countryside and enable us, for the most part, simply to do more efficiently what could be done without them at much greater cost in labor.

But money has one feature that these other machines do not share. Because it is so pervasive, when it gets out of order, it throws a monkey wrench into the operation of all the other machines. - Milton Friedman, 1968

PS The above has been written on the fly, may miss some connections, but seems to make sense. Hope it does the same when it meets the reader's eye :) If my last para above doesn't make sense at first, read the quote of Friedman and then re-read my para.

What I am saying in essence is that Money Supply increases take time to show their impacts. Asset-price inflation and/or consumer price inflation will follow Money Supply increases. Asset prices have to revert to their historical trend-lines and relationships with other economic variables such as income etc. The reversion will be in Real terms, and very likely in Nominal terms too. When that correction comes, it is not going to be pretty. When the economic history of the first decade of the 21st century is written, the rally of 2009 may not occupy more than a square inch.

04 November 2009

An edit in the Business Standard today highlights the changes in thinking with regard to forex reserves and cross-border flows:

This episode has clearly highlighted the need for re-assessing the benefits of accumulating large foreign exchange reserves. Once viewed as inefficient by the orthodoxy, “self-insurance” is now being seen as a legitimate crisis-management strategy.

Alongside this, the orthodoxy about the desirability of capital inflows is also being questioned. Brazil is a prominent example of having recently imposed a tax on short-term portfolio inflows, a variant of the class of instruments generally known as Tobin taxes.Contrary to the orthodox view that Tobin taxes will queer the pitch for foreign capital, a clear delineation of the transactions on which they are to be levied may actually incentivise more desirable long-term portfolio and direct investment inflows because they promise a more stable balance-of-payments and exchange-rate environment.

RBI Deputy Governor's speech at the FSA Turner Review Conference also deals with the space for unorthodoxy

Much of the current debate on many issues centres on the epicenter of the crisis, the developed economies with relatively advanced financial systems. The emerging markets, though, can bring a different perspective from their own past experience. Many of the emerging countries, including India, are part of the global effort in search of a harmonized framework but certain key differences in perspectives in these two sets of economies need to be appreciated. The status of the financial sector of the emerging economies is different from that of the advanced economies with different set of imperatives having different implications for the trade off between financial stability on the one hand and financial development, financial inclusion and growth, on the other. For instance, with regard to identification and mitigations of sources of systemic risk, the emerging market concerns are heightened because of the fact that many sources of systemic risk lie outside their jurisdictions. There could also be the issue of negative externality of larger than warranted capital requirements without careful calibration which could adversely impact the flow of credit to productive sectors, particularly in bank funding based financial systems. Emerging economies are faced with the challenge of managing volatile capital flows which is not a source of systemic vulnerability for developed economies,

Clearly the experience of the developing/emerging economies has much to offer in reshaping the prevalent ideology.

03 November 2009

Frustrated with the inability of economics to develop realistic thinking, fund manager and global investor George Soros has decided to set up an institute 'New Economic Thinking'

The group, to be called the Institute of New Economic Thinking, will gather luminaries in the field of economics to reflect on the ideas that allowed the latest economic crisis to transpire and to bring new ideas to a profession that some argue has become too deeply entrenched in free-market ideology.

The group’s advisory board will be studded with economists such as Jeffrey Sachs, George Akerlof, Kenneth Rogoff and Joseph Stiglitz as well as public commentators such as Anatole Kaletsky and John Kay, a Financial Times columnist. Mr Soros is pledging $5m a year for 10 years.

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